Question

For the current year (Y-4) Fabco has gross income of $100,000 and deductions of $110,000 for regular tax purposes. Three years ago (T-1) taxable income was $5,000. Two years ago (Y-2) taxable income was $10,000. Last year (Y-3) taxable income was $300,000. Next year (Y-5) it is anticipated that taxable income will be $275,000. Assume alternative minimum tax does not apply.

What are the tax consequences to Fabco in the current year (Y-4)?

What alternatives does Fabco have?

Answer 1

Fabco has following data

Year Gross Income deductions Taxable Income

Y-1 - - $5000

Y-2 - - $10000

Y-3 - - $ 300000

Y-4 $100000 $110000 - $10000 (NOL)

Y-5 - - $275000

A business if it has total deduction more than its gross income than the difference between them is to be called " Net Operating Loss " (NOL) for that year as we can calculate for this given problem for year 4 as $100000 - $110000 = $10000(NOL).

A business has option to set off its current year NOL to carrybackward for two years and carry forward for 20 years.

So Fabco as it has taxable income in last previous year (Y-3) as $300000 can carry back its current year (Y-4) NOL and can claim refund of tax from tax autorities after completing due documentation and procedures.

And Fabco at its choice also has option to carry forward its current year NOL up to next 20 years. as Fabco anticipated that it will have taxable income of $275000 in year 5 , so fabco can reduce it year 5 taxable income by it current year NOL of $10000 than its Y-5 taxable income will be $275000 - $10000 = $265000.

So Fabco has above two alternatives as no tax liability for current year (Y-4).

But it is prudance from the point of time value of money, that the tax saving should be applied against the earlist periods available rather than later periods.

So above is the solution to the Fabco problem.